A Parent Burned by Incentives, Microcosm of Finance and Society?

Family Business – WSJ.com

In today’s WSJ, there’s a review of a new book called Parentonomics: An Economist Dad Looks at Parenting, in the mold of the excellent book Freakonomics: A Rogue Economist Explores the Hidden Side of Everything.

Who is ready to write “Deming-nomics: A Statistician Implores Us to Eliminate Incentives and Substitute Leadership”?

In Parentonomics, there’s a story that shouldn’t surprise any Deming disciple:

Incentives may work, but they sometimes lead to unexpected consequences, such as the time Mr. Gans implemented a point system to, uh, incentivize one of his children to make it through the night with a dry diaper. The little one — child of an economist, remember — naturally took the diaper off before going to sleep. The bedding was soaked, but the diaper was immaculate.

Classic “gaming the system” behavior. Children are clever… they learn to blame people (it comes naturally to them, actually) and they learn to game the system to get their prize.

So this brings me back to an article I was going to blog about a few weeks ago, a WSJ piece that blames performance bonuses and incentives for our financial collapse.

Opinion: Street Bonuses Are Outrage – WSJ.com

Again, if we had only listened to Dr. Deming:

It is merely this: That Wall Street’s compensation system isn’t just aesthetically displeasing to liberal snobs. It is the very heart of the problem. According to Bill Black, a professor of economics and law at the University of Missouri-Kansas City and an authority on dysfunctional financial systems, “It is the compensation system that has proved to be the weak point in everything critical that went wrong, that has produced a global catastrophe.”

At each stage of the disaster, Mr. Black told me — loan officers, real-estate appraisers, accountants, bond ratings agencies — it was pay-for-performance systems that “sent them wrong.”

This recession/crisis/near-depression has clearly been “made made” due to excesses and fraud in the financial sector, and it’s dragging down the world economy. Thanks, guys.

As the WSJ piece continues:

The need for new compensation rules is most urgent at failed banks. This is not merely because is would make for good PR, but because lavish executive bonuses sometimes create an incentive to hide losses, to take crazy risks, and even, according to Mr. Black, to “loot the place through seemingly normal corporate mechanisms.” This is why, he continues, it is “essential to redesign and limit executive compensation when regulating failed or failing banks.”

This WSJ article from Friday perfectly highlights the skewed risk/reward balance in Wall Street gambling, I mean “investing.” When you bet big with other people’s money and win, you get a huge payout. Short-term thinking, short-term rewards. Then, when you lose big, you lose nothing personally and get to start a hedge fund (who would give that guy money now?).

So President Obama has demanded caps on executive pay for firms that receive federal bailout money, limiting pay to $500k a year, which is more than the President makes (well, all of the Air Force One time doesn’t count as taxable income, right Sen. Daschle?).

There’s always a way around the system…. the WSJ reported yesterday that banks and companies will just be creative in paying their executives. They’ll do deferred compensation, restricted stock, and even using the loophole that the top leaders won’t technically be officers of the company. Where there’s a will there’s a way. If you want to ship contaminated peanut products, all of the government oversight and rules won’t stop you. If you want to overpay executives, the government can’t stop that, either.

It’s a shame that decency, ethics, and common sense long ago left the building. It’s like these finance geniuses took off their diapers and, well, you know…

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Mark Graban's passion is creating a better, safer, more cost effective healthcare system for patients and better workplaces for all. Mark is a consultant, author, and speaker in the "Lean healthcare" methodology. He is author of the Shingo Award-winning books Lean Hospitals and Healthcare Kaizen, as well as The Executive Guide to Healthcare Kaizen. His most recent project is an eBook titled Practicing Lean that benefits the Louise H. Batz Patient Safety Foundation, where Mark is a board member. Mark is also the VP of Improvement & Innovation Services for the technology company KaiNexus.

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5 Comments on "A Parent Burned by Incentives, Microcosm of Finance and Society?"

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  1. Mark Welch says:

    How true. It all comes down to ethics. I don’t know if anyone reading this ever heard of Roman Catholic Bishop Fulton Sheen, who did many lectures in the 1950’s, but he once gave a lecture on the rise and fall of the world’s greatest civilizations. Of those that fell, I believe about 75% of them crumbled from within due to decaying ethics/morality/values. Is the current economic crisis a wakeup call? Are we next?

  2. Jason says:

    Good points, Mark.

    To be fair to the President, no matter who it is: the use of Air Force One is not a perk; it’s the best way to safely move the President (and his entourage) around.

  3. curiouscat says:

    Very true. Alfie Kohn already wrote it: “Punished By Rewards: The Trouble with Gold Stars, Incentive Plans, A’s, Praise, and Other Bribes.”

  4. glanger says:

    I could not agree more, when will we start realizing that driving people to do things by incentives and rewards does not work – for anybody except when training animals? We, as people, need a meaning for doing the things we do. However when it simply is to get more of what we already have it becomes greed. Simply doing something because we have to, or because we are asked to, only works in the short term. In order for us to really do our best we have to be passionate about it and passion does not come from yearly employee incentive plans or monetary gifts. Somehow we all think that we can use the old “carrot on a stick” method, but that usually only works for asses.

  5. Mark Graban says:

    Jason — you’re right. I wasn’t literally suggesting that that perk be taken away, but I do believe it fits the definition of necessary perk.

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